Well Rounded View
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Islamic Finance Comes of Age
by Tariq Masood Shaikh, Chairman, Islamic Finance Council UK
Could the contrast be more stark?
Within the last 18 months the “conventional” banking system has experienced turmoil on a scale not seen since the Second World War. The decline in balance sheet values has been measured in billions and the complex and exotic financial instruments on which much of the last decade’s growth has been based are now classified as “toxic”. World-leading financial institutions, where they have not disappeared entirely, have had to go cap in hand to seek government bailouts, and may yet face the spectre of nationalisation. The fallout is now affecting the “real” economy in all too obvious a way.
Islamic finance on the other hand, while not immune from the economic climate in general, has continued to expand exponentially. Within the last decade it has grown from a relatively localised role in its traditional markets to a fully fledged global industry, competing for assets estimated at $750 billion in 2006 and predicted to exceed $1 trillion by 2010. Shari’a-compliant institutions and products are now well developed in retail banking, asset management, capital markets (via the sukuk or Islamic bond) and most recently insurance (with the development of takaful, a Shari’a-compliant mutual product).
The continued growth of Islamic finance, which has essentially been demand driven, has clearly been significantly supported by the scale of Middle East sovereign wealth funds and the strength (until recently at least) of the petrodollar. However, looking more closely at the specific causes of the present crisis in the conventional banking field, it is worth asking whether these could have arisen equally under a Shari’a-compliant system. In my view the answer must be no, as much of what lies at the root of the current malaise could not arise within Islamic finance, or at any rate not in the same form.
Shari’a compliance involves a number of fundamental principles which are directly relevant here. The exclusion of conventional interest-based products (probably the best known aspect of the Shari’a’s approach to finance in the wider world) has meant that Islamic institutions have no exposure to CDOs and other exotic instruments which have been at the heart of the current woes, thus avoiding the massive write-downs. In addition, Islamic investment funds have been in the top quartile of performance over the past 18 months as the ban on receiving interest prevents them from investing in conventional banks, sheltering them from the dramatic falls in their share prices.
There are other principles inherent to Islamic finance which have also contributed towards a less volatile macro-economic environment. For example there is a general legal maxim (quawid) which restricts the trading of assets which you do not own. Thus “short selling”, which increased the downward pressure on many listed stocks, would effectively be outlawed. The general prohibition on speculation and gambling (maisir) coupled with the Shari’a principle that contracts must have complete transparency and avoid any unnecessary uncertainty (gharaar) curtail the use of a number of conventional derivative structures and complex structured products (many of which appear not to have been fully understood by the ratings agencies or indeed the senior executives of the banks who were trading in them).
Certainly many of these inherent principles would lead to a more stable financial environment, with financing mechanisms being more aligned with the ‘real’ economy than has been the case of late.
While the Islamic finance industry remains concentrated in the traditional centres of Middle East and Malaysia, over the past decade the UK has established itself as the premium hub in the western world. Several conventional banks are providing Islamic products through “window” operations and since 2004 the UK has seen the establishment of five stand-alone Islamic banks (four wholesale and one retail) plus an insurance provider. In addition, Islamic financing has begun to appear in the capital markets and private equity fields – notable recent examples include the funding of the planned development of the iconic “Shard” Tower at London Bridge and the acquisition of Aston Martin.
The UK government has taken an active part in this process, and in particular in a series of Finance Act reforms has sought to establish a “level playing field” as regards the tax and stamp duty treatment of Shari’a-compliant finance products. In this area, the Islamic Finance Council UK (IFC) Board Members continue to play an active role in contributing to both the UKTI and Treasury Islamic finance sub-committees. As recently as December of last year HM Treasury published a further paper on policy initiatives designed to encourage the development of Islamic finance in the UK. A key point this paper recognises is that Islamic finance is open to all, not just the Muslim community.
Scotland should be well placed to take advantage of this burgeoning market. It has over centuries shown itself a pioneer in the development of new financial products – savings banks, unit trusts, “with profits” funds and many others saw their origins or their early development here. More broadly, Islamic finance has at its core the concept of “ethical finance” and this again accords well with the financial culture of Scotland, which both historically and in recent times has taken a lead in responding to the demand for products with these values at their core. When therefore we decided in 2005 to establish the IFC as a not-for-profit body to promote and develop the Islamic finance industry, Scotland seemed a natural home. From its base here the IFC has established and run a number of educational and awareness events and programmes both locally and internationally and has received endorsement by the UKTI and international bodies such as the Central Bank of Malaysia‘s ISRA.
Islamic finance remains a youthful industry and much remains to be done – standardisation of Shari’a interpretation is a key issue and a shortage of experienced Shari’a scholars remains a problem (an aspect which the IFC is actively seeking to address). To date, much of the effort within the industry has been devoted to producing equivalents to conventional financial products. The turmoil in these conventional markets however, in my view, presents the industry with a unique opportunity to pioneer truly innovative solutions based on the ethical principles by which it is underpinned. The opportunity for Islamic finance to add value to the global financial system by presenting an alterative paradigm to produce economic stability has never been better – and I see no reason why Scotland should not take a leading role.
Whilst London with its strong trading and origination capability will always lead the way in terms of capital markets, Scotland’s proven ability to innovate and its proud heritage in ethical finance provides the ideal foundation for it to emerge as a key fund and wealth management and intellectual centre for Islamic finance. It is not too fanciful to suggest that in a few years Scotland could become a real Islamic financial hub. The opportunity for those that are bold is there to take.
Tariq Masood Shaikh
Chairman, Islamic Finance Council UK
View Tariq Masood Shaikh's Biography (click on this link and scroll down the page)
View Islamic Finance Council UK's website
View details of Scotland's first Islamic Finance Conference on 2nd April 2009, hosted by Tods Murray
View details of Tods Murray's Banking and Finance Team
Contact Graham Burnside - Head of the Tods Murray Banking and Finance Service and a member of the Executive Board of the Islamic Finance Council UK